How to Claim the Early Withdrawal Penalty Deduction

The penalty your bank or credit union charged for cashing out a CD before maturity is deductible on your federal return, and you claim the early withdrawal penalty deduction on Schedule 1 (Form 1040), Line 18, using the amount reported in Box 2 of your Form 1099-INT.¹ It comes off your income before the standard-deduction-versus-itemize decision, so every filer who paid such a penalty benefits.²

What Penalty Qualifies

The deduction covers interest or principal you forfeited to a financial institution because you broke the term of a time deposit. A CD cashed out before maturity is the classic case. Credit union share certificates work the same way. The statute reaches penalties forfeited to banks, mutual savings banks, savings and loan associations, cooperative banks, and similar institutions for premature withdrawal from a “time savings account, certificate of deposit, or similar class of deposit.”²

If you broke a 12-month CD after four months and the bank clawed back three months of interest, that forfeited amount is what you deduct. Age, income, and filing status don’t affect eligibility.

Find the Amount on Your 1099-INT

By late January or early February, the institution that charged the penalty sends Form 1099-INT. Box 1 shows the interest you earned for the year. Box 2 shows the early withdrawal penalty.³ The Box 2 figure is exactly what you deduct.

If your early withdrawal involved a bond or another original issue discount instrument rather than a standard CD, the penalty appears in Box 3 of Form 1099-OID instead. The deduction works the same way.⁴

Compare the Box 2 amount against your own records of what the bank withheld. If they don’t match, call the institution and ask for a corrected 1099-INT. The IRS receives its own copy, so putting a different number on your return without a correction is a reliable way to trigger a notice.

Where to Enter It on Your Return

Enter the penalty on Schedule 1 (Form 1040), Part II, Line 18.¹ If you have Box 2 amounts from more than one institution, add them together and enter the total on that single line.

Part II adjustments total on Line 26 of Schedule 1, which transfers to Line 10 of Form 1040. Your AGI on Line 11 is your total income minus that Line 10 figure.⁵ Because this is an above-the-line adjustment, the deduction reduces your AGI whether you take the standard deduction or itemize.

Report the interest itself as usual. Box 1 goes on the interest income line of your return, and Box 2 goes separately on Schedule 1, Line 18. The institution reports gross interest without netting the penalty against it, so you handle the offset through the deduction.⁶

When the Penalty Is Larger Than the Interest You Earned

Cash out very early in the term and the penalty can exceed the interest the account produced. Suppose you earned $200 in interest but the bank charged a $500 early withdrawal penalty. You still deduct the full $500. The statute doesn’t cap the deduction at the interest earned.²

On the return, you report $200 of interest income and take a $500 deduction on Schedule 1, for a net $300 reduction against your other income.

If You Missed the Deduction in a Prior Year

File Form 1040-X to claim it retroactively. The deadline is three years from the date you filed the original return, or two years from the date you paid the tax, whichever is later.⁷ Adjust Schedule 1, let the lower AGI carry through, and the refund is the difference in tax.

What This Deduction Does Not Cover

The write-off is limited to forfeited interest or principal on a time deposit. Other penalties that sometimes get confused with it don’t qualify:

The 10% additional tax on distributions from an IRA, 401(k), or similar retirement plan before age 59½. That charge is calculated on Form 5329 and reported on Schedule 2, and it is not deductible.⁸⁹
Additional taxes on non-qualified distributions from Health Savings Accounts and Coverdell Education Savings Accounts. These are taxes on the distribution, not forfeited interest on a time deposit.
IRS penalties for late filing, inaccuracy, or underpayment of estimated tax.
Ordinary bank fees such as overdrafts, account maintenance, or wire transfers.

If you received a Form 1099-R rather than a 1099-INT, you’re dealing with a retirement distribution, not a time-deposit penalty. Form 1099-R reports the distribution with a code indicating whether the 10% additional tax applies, and nothing on it feeds into the Schedule 1, Line 18 deduction.¹⁰

The test is straightforward. If a financial institution forfeited your interest or principal because you broke the term of a time deposit, the penalty is deductible on Schedule 1, Line 18. Anything else charged by anyone else stays off that line.

1
Internal Revenue Service. 2025 Schedule 1 (Form 1040)
2
Office of the Law Revision Counsel. 26 USC 62 – Adjusted Gross Income Defined
3
Internal Revenue Service. Form 1099-INT (Rev. January 2024) – Interest Income
4
Internal Revenue Service. Form 1099-OID – Original Issue Discount
5
Internal Revenue Service. Case Study 2 – Penalty on Early Withdrawal of Savings
6
Internal Revenue Service. Instructions for Forms 1099-INT and 1099-OID – Specific Instructions for Form 1099-INT
7
Internal Revenue Service. Topic No. 308, Amended Returns
8
Office of the Law Revision Counsel. 26 USC 72 – Annuities; Certain Proceeds of Endowment and Life Insurance Contracts
9
Internal Revenue Service. Instructions for Form 5329 (2025)
10
Internal Revenue Service. 2025 Instructions for Forms 1099-R and 5498